Margins matter

You don’t need a killer idea to succeed in business, but you do need to find the right opportunities to make a profit, writes Simon Cook.

You don’t need a killer idea to succeed in business, but you do need to find the right opportunities to make a profit, writes Simon Cook.

People often tell us they’d love to start their own business but just don’t have a great idea. We reply business isn’t about ideas; it’s about finding opportunities to make a margin.

You don’t need to have invented the wheel or the next killer gadget to start a business. The first businesses simply traded goods, based on knowledge or an informed guess of what would sell.

On a recent taxi journey in Holland (a nation with a proud trading history like the UK), the driver explained to me how he supplemented his income buying large lots of products on eBay and selling the lots in smaller batches; he’s made thousands selling garden furniture recently.

In his book The Adventure Capitalist former City man Conor Woodman attempts to double his $50,000 investment by travelling the world and trading goods from one place to another. His speculation that he could buy wine in South Africa and sell it at a great profit in China proved to be right. His other gambles on camels and horses lost money and he made small profits on his jade, coffee and chilli sauce trades.

This matches our experience in that some investments will pay handsomely, others make a small profit and a few may fail. If you’re not comfortable to lose money occasionally, then you are in for a big shock. The trick is to try enough things to spread your risk and to have as much knowledge about your market as possible before you invest a lot of time and capital.

Knowledge is power

When we meet an entrepreneur and he or she pitches their new gadget, service or killer app, our first question is always: ‘Where’s the margin?’ We look for in-depth knowledge of the end customer demand. It’s vital for us to know how the business will make connections with its customers so as to understand if there are any additional channels of delivery that might affect margins.

Only then do we get into the technology and the product itself to understand what it costs to make and how it works. The reason that technology investing can be so lucrative is because occasionally the gap between customer demand and the cost of the technology will be very high with margins often as exalted as 50 to 95 per cent. This is because often there will be no competition or alternative way of fulfilling that customer demand. This high margin potential is what drives the revenue multiples paid in technology M&A and is an important factor in attracting venture capital.

So how easy is it to measure this potential customer demand and margin before investing in or building a product?

The truth is that it is not easy at all. Often customers don’t know they want something until it is available, or more usually they have seen others using it and getting great benefits from the product or service before they rush to sign up. Very few want to be the first customer, so assessing potential demand requires some speculation and a leap of faith.

Predicting profits

To get a better feel for the opportunity, we will speak to existing industry players and assess how the margins are currently created. We’ll also take into account the experience of the founders and management; if a team has operated in a market for a very long time they’ll have intimate knowledge of the margin structures, and the fact these people are willing to invest their time and cash in a new opportunity speaks volumes about the potential.

So if you are waiting for that elusive killer idea to spur you into starting your own business, you might be better studying a market and identifying where margins are to be made. By applying novel technology and business models to this you can often find lucrative opportunities.

Simon Cook is the CEO of venture capital firm DFJ Esprit. For more information see:

Nick Britton

Nick Britton

Nick was the Managing Editor for when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

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